What’s next for the evolution of the Property ETF’s eco-system?

If ever there was a perennial asset class that gets the most attention, then property must surely be that asset.  With almost a decade or more of next to zero interest rates since the Global Financial Crisis of 2008, none of us should be surprised by the amazing statistics that has gone hand-in-hand with the growth of the property market.

For example, just focusing on the UK market, according to the Government’s Land Registry website, in the UK average house prices increased by 12.4% over the year to April 2022, and specifically London property has increased by 60% over the last 10 years. The UK is not alone in showing such strong growth figures, a trend that has been displayed in many other towns and cities across the globe (See Ref 1, Ref 2).

It has been over 20 years since iShares launched the first ETF that offered investors exposure to the US property market, and since that inaugural launch, the niche sector of property ETFs has grown beyond all recognition.  According to Algo-Chain’s ETF database (see Ref 3), as of July 2022, there are over 170 ETFs listed in the US and Europe, covering a broad range of property related investment themes.

Many of the bulge bracket firms are represented in that list, including Vanguard, JP Morgan, Amundi, BNP Paribas, SPDR, HSBC & Invesco amongst others.  Let’s take a moment to familiarize ourselves with one of the key constructs that has become part and parcel of the investment landscape, and that is the creation of the concept of a REITs investment vehicle, which is short for Real Estate Investment Trust.  The basic idea is to eliminate or obtain a reduction in corporate income taxes, on the basis that the aim of the fund is to distribute nearly all its annual profits to investors.

One advantage of Property ETFs is that they have historically shown themselves to be liquid in volatile markets, partly due to the benefits of operating with both a primary and secondary market for trading.  It wasn’t that long ago when at the onset of the Covid Pandemic L&G, Columbia Threadneedle and BMO all suspended a number of property funds due to valuation uncertainty, unlike all of the Property ETFs which operated as per normal (See Ref 1).

Anybody that has bought a house knows that taking out a mortgage provides the investor with a degree of leverage.  For a deposit of £40k, a credit worthy investor can take ownership of a £400k house.  And so it is with REITs, where there is a subset of funds often called mortgage REITs that manage their interest rate and credit risks through the use of derivatives.

As with many tax-incentivised investments, this new wrapper became very popular in the US before crossing over to the UK & Europe.  Indeed, if one looks at the top ten holdings of many ETFs, don’t be surprised to see that REITs may dominate that list.

As an investor with so many Property / REITs available, one is almost spoiled for choice.  When selecting an ETF, the key aspects that one needs to consider include which geographical exposure is included, e.g. Asia, Europe or the US, does the ETF provide exposure to the Retail or Commercial property sector, and increasingly which specific commercial sub-sectors are being targeted?

Given how strong the property markets have been over the last 20 years, it is perhaps surprising to learn that this sector of the ETF market has shown itself to be volatile (See Ref 2 & 3).  Post the Global Financial Crisis of 2008, it was not unusual to see that many property funds were down 50%, and a small number even more than that. For that reason, it goes without saying that any investor needs to study the details behind the benchmark index that the ETF tracks.  Only here will you find out how the benchmark’s inclusion rules dictate what’s in the portfolio and how it will be constructed and maintained on an ongoing basis.

It’s been very interesting keeping up with the innovation in property index construction.  One recent example is the idea of constructing a benchmark index that looks to track property investments offering exposure to firms with green building certification and favourable energy usage.  While many aspects of the ESG movement are somewhat nuanced, the idea of factoring in sustainability into one’s property investments has its obvious merits.

A second area where innovation is showing its place, is the idea of identifying those commercial real estate opportunities that are deemed to be recession proof, a sector that has been dubbed the New Economy Real Estate.  Such sectors cover Cloud Computing, Supply Chain Logistic, 4G & 5G Connectivity and the Life Sciences, an idea that sees Thematic Investing extended to property ETFs.

And so the evolution of the ETF industry continues apace, where the central idea is to provide the next generation of ETFs that increasingly refine the granularity of the exposures on offer.

Linear provide access to most global equity markets and all key financial instruments: Equities, Fixed Income, Futures, Options and all the structures needed to support these instruments – SWAPS/PB/Stock Loan and derivative instruments.

Ref 1 – https://citywire.com/wealth-manager/news/uks-largest-property-fund-gated-as-firms-lock-up-11bn-in-assets/a1337060
Ref 2 – https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/april2022
Ref 3 – https://www.globalpropertyguide.com/
Ref 4 – https://www.algo-chain.com/ETF/